Lecture4 - Futures and Forwards

Lecture 4
Futures & Forwards
Refs.: Hull chapters 2, 3 & 5
D.Andriosopoulos - AG929 & AG925 1

Futures Contracts
• Agreement to buy or sell an asset for a
certain price at a certain time
• Available on a wide range of assets
• Exchange traded
• Specifications need to be defined:
– What can be delivered,
– Where it can be delivered, &
– When it can be delivered
• Settled daily
• Similar to forward contract, but a futures
contract is traded on an exchange
Exchanges Trading Futures
• CME Group (formerly Chicago Mercantile
Exchange and Chicago Board of Trade)
• NASDAQ OMX
• Tokyo Financial Exchange (TFE)
• Intercontinental Exchange (ICE)
• LCH (Clearnet)
• and many more
• EU regulation - ESMA
• US regulation (of futures markets) - Commodity
Futures and Trading Commission (CFTC)

Examples of Futures Contracts
Agreement to:
– Buy 100 oz. of gold @ US$1400/oz. in
December
– Sell £62,500 @ 1.4500 US$/£ in March
– Sell 1,000 bl. of oil @ US$90/bbl. in April

Convergence of Futures to Spot
Contango Backwardation
Futures
Price Spot Price
Futures
Spot Price
Price
Time Time
(a) (b)

Convergence
FTSE100 Dec2016 : Spot FTSE100
7,500.00
7,000.00
6,500.00
6,000.00
5,500.00
5,000.00
Friday, March Monday, April Wednesday, Saturday, June Monday, July Thursday, Sunday, Tuesday, Friday, Sunday,
11, 2016 11, 2016 May 11, 2016 11, 2016 11, 2016 August 11, 2016 September 11, October 11, November 11, December 11,
Futures Dec 2016 FTSE 100 2016 2016 2016 2016

Source: Thomson Reuters
2,200.00
2,300.00
2,400.00
2,500.00
2,600.00
2,800.00
2,900.00
3,000.00
2,700.00
08-Oct-2018
10-Oct-2018
12-Oct-2018
14-Oct-2018
16-Oct-2018
18-Oct-2018
20-Oct-2018
Source: Thomson Reuters

22-Oct-2018
24-Oct-2018
26-Oct-2018
28-Oct-2018
30-Oct-2018
01-Nov-2018
03-Nov-2018
05-Nov-2018
07-Nov-2018
09-Nov-2018
11-Nov-2018
SP500 Mini
13-Nov-2018
15-Nov-2018
SPX vs SPX mini
backwardation
17-Nov-2018
SP500
19-Nov-2018
21-Nov-2018
D.Andriosopoulos - AG929 & AG925

23-Nov-2018
25-Nov-2018
27-Nov-2018
contango
29-Nov-2018
01-Dec-2018
03-Dec-2018
05-Dec-2018
07-Dec-2018
Contango/backwardation
09-Dec-2018
11-Dec-2018
13-Dec-2018
15-Dec-2018
17-Dec-2018
7
19-Dec-2018
Margins
• A margin is cash or marketable securities
deposited by an investor with his or her
broker
• The balance in the margin account is
adjusted to reflect daily settlement
• Margins minimize the possibility of a loss
through a default on a contract

Example of a Futures Trade
• An investor takes a long position in 2
December gold futures contracts on June
5
– contract size is 100 oz.
– futures price is US$1,250
– initial margin requirement is
US$6,000/contract (US$12,000 in total)
– maintenance margin is US$4,500/contract
(US$9,000 in total)

A Possible Outcome
Day Trade Price Settle Price Daily Gain Cumul. Margin Balance Margin
($) ($) ($) Gain ($) ($) Call ($)
1 1,250.00 12,000
1 1,241.00 −1,800 − 1,800 10,200
2 1,238.30 −540 −2,340 9,660
….. ….. ….. ….. ……
6 1,236.20 −780 −2,760 9,240
7 1,229.90 −1,260 −4,020 7,980 4,020
8 1,230.80 180 −3,840 12,180
….. ….. ….. ….. ……
16 1,226.90 780 −4,620 15,180

Margin Cash Flows When Futures Price
Increases
Clearing House
Clearing House Clearing House

Member Member
Broker Broker
Long Trader Short Trader

Margin Cash Flows When Futures Price
Decreases
Clearing House
Clearing House Clearing House

Member Member
Broker Broker
Long Trader Short Trader

Terminology
• The party that has agreed to buy has what is termed a long
position
• The party that has agreed to sell has what is termed a short
position
• Spot Price is the price an asset can be bought and sold

immediately
• Futures price at which a party contracts to buy or sell an asset
at a future date
• Basis is the difference between the spot and futures price -
there is basis risk.
• Open interest: the total number of contracts outstanding
– equal to number of long positions or number of short positions
• Settlement price: the price just before the final bell each day
– used for the daily settlement process
• Volume of trading: the number of trades in one day
• Closing out a futures position involves entering into an
offsetting trade.(most contracts are closed out before maturity).
Futures specs
• https://www.theice.com/products/219/Brent-
Crude-Futures
• https://www.theice.com/products/213/WTI-
Crude-Futures
• http://www.cmegroup.com/trading/energy/crud
e-oil/light-sweet-
crude_contractSpecs_futures.html
• http://www.cmegroup.com/trading/agricultural/l
ivestock/live-cattle_contract_specifications.html
• https://www.theice.com/products/37089079
Crude Oil Trading on May 26, 2010
Open High Low Settle Change Volume Open Int

Jul 2010 70.06 71.70 69.21 71.51 2.76 6,315 388,902
Aug 2010 71.25 72.77 70.42 72.54 2.44 3,746 115,305
Dec 2010 74.00 75.34 73.17 75.23 2.19 5,055 196,033
Dec 2011 77.01 78.59 76.51 78.53 2.00 4,175 100,674
Dec 2012 78.50 80.21 78.50 80.18 1.86 1,258 70,126

Closing out a futures position
8th January
An investor goes long in ten G4S March futures
contract (1 contract represents 1,000 shares)
Futures price = 263.34
14th January
The investor closes out the position by going short
in the same number of contracts
Futures price = 270.52
This is called a reversing trade or closing out

Futures Example
10 long contracts in G4S over 8th-14th January, 2013.
Initial margin is 15p per share
• i.e. 10 x 1,000 x 15p = £1,500 (for 10 contracts)
Assume maintenance margin is 75% of initial margin

(i.e. 1,125)
If the balance falls below £1,125 then a margin call
is made to bring the balance back to £1,500.
Margin Account
Date Futures Gain/Loss Gain/Loss Balance of Margin Call
settlement on 10 margin
price contracts account
8 Jan 263.34 Position opened £1,500
9 Jan 264.94 1.6 £160 £1,660 -
10 Jan 261.83 -3.1 -£311 £1,349 -
11 Jan 267.93 6.1 £610 £1,959 -
14 Jan 270.52 2.59 £259 £2,218 -
Position Closed
Total Gain/Loss 7.18 £718 £2,218

Total gain / loss on futures position
F0=Futures price when position is opened
FT=Futures price when position is closed
To close-out a long position it is FT - F0

(270.52 - 263.34 = 7.18p)
Typically Gains/Losses go through P/L (Fair Value accounting, mark-to-market)

If pure Hedger then can go through Comprehensive Income (CI)
(Depends on Accounting Rules e.g. IAS 39, IFRS 9 https://www.iasplus.com/en/standards/ifrs/ifrs9)

Speculation
• On 8th January, 2013 the FTSE 100 was 6053.6
• A speculator believes a significant rise will
occur in the next few days
• The futures price for March was 6014.0.
• Expecting a rise the speculator goes long in
500 futures contracts at 6014.0. The contracts
are for £10 per index contract.
• The investor has taken a “naked” position in
futures and has full exposure to risk.
FTSE 100 index spot and futures prices
over 8-14 Jan 2013
Date Spot Index Futures Index
8 Jan 6053.6 6014.0
9 Jan 6098.6 6053.5
10 Jan 6101.5 6054.5
11 Jan 6121.6 6071.0
14 Jan 6107.9 6072.5
The speculator decides to close her position on 14 Jan.
-Reversing Trade
-500 Short Contracts @ 6072.5

Gain/Loss on Long position
= ( FT – F0 ) x £10 x 500 contracts
= (6072.5 – 6014.0) x £10 x 500 contracts
= 58.5 x £5,000 = £292,500 (over 5 trading days)
Note: Margin = £3,020/contract =

£1.51m for 500 contracts

Arbitrage
• When equivalent assets trade at different prices arbitrageurs buy in the
cheaper market and sell in the more expensive. This provides gains
without risk. Such opportunities should be rare. The activities of
arbitrageurs keep prices in line.
• In rational, well-informed markets equivalent assets have the same

price. Hence, in equilibrium there are no arbitrage opportunities. This
“no-arbitrage” principle is the basis for most derivatives.
• Arbitrage opportunities can occur if the equilibrium relationship

between futures and spot prices is significantly disturbed.
• Equilibrium is based on the theoretical relationship between futures

and spot prices (‘spot-futures-parity’). Opportunities for arbitrage arise
if there are information gaps/delays in pricing adjustments such as
when the same asset is traded on different markets and/or in different
countries.
Hedging
• Long Hedge: If one is committed to buying assets at a
future date she can fix the future price by taking a long
position in futures on the asset.
– It is a hedge against the possibility of a rise in price.
• Short Hedge: If one is committed to selling assets at a
future date she can fix the selling price by taking a short
position in futures on the asset.
– It is a hedge against the possibility of a fall in price.
– Short hedge is also used to protect assets already held, when
there is no intention to sell.
• In both long and short hedges, changes in the value of the
asset are offset (or partially so) by changes in the value of
the position in futures.
• Futures are typically cash settled at expiration or earlier
(with a reversing trade)
Arguments against Hedging
• Shareholders are usually well diversified
and can make their own hedging decisions
• It may increase risk to hedge when
competitors do not
• Explaining a situation where there is a loss
on the hedge and a gain on the underlying
can be difficult

Long Hedge for Purchase of an Asset
F1 : Futures price at time hedge is set up

F2 : Futures price at time asset is purchased
S2 : Asset price at time of purchase
b2 : Basis at time of purchase
Cost of asset S2
Gain on Futures F2 −F1
Net amount paid S2 − (F2 −F1) =F1 + b2

Short Hedge for Sale of an Asset
F1 : Futures price at time hedge is set up

F2 : Futures price at time asset is sold
S2 : Asset price at time of sale
b2 : Basis at time of sale
Price of asset S2
Gain on Futures F1 −F2
Net amount received S2 + (F1 −F2) =F1 + b2

Choice of Contract for hedging
• Choose a delivery month that is as close
as possible to, but later than, the end of
the life of the hedge
• When there is no futures contract on the
asset being hedged, choose the contract
whose futures price is most highly
correlated with the asset price. This is
known as cross hedging.

Optimal Hedge Ratio
Proportion of the exposure that should optimally be hedged
is
sS
h*  r
sF
where
sS is the standard deviation of DS, the change in the spot
price during the hedging period,
sF is the standard deviation of DF, the change in the futures
price during the hedging period
r is the coefficient of correlation between DS and DF.

Perfect/imperfect hedge
• Perfect hedge
– The asset to be hedged must be identical to the
underlying futures contract
– The hedge period and life of the futures contract are
identical
• A perfect hedge makes the value of a future position certain.
If either of the above conditions is not met then it is
imperfect hedge.
• Imperfect hedge
– There is no futures contract with an expiration date
matching the required hedging period. Hence, use
contract with expiration closest to (but after) end of
hedge period.
– There is no futures contract on the asset you wish to
hedge, hence you may use futures contract on a
similar asset (cross-hedging) 30
Example
• Airline will purchase 2 million gallons of jet
fuel in one month and hedges using heating
oil futures
• From historical data sF =0.0313, sS =0.0263,
and r= 0.928
0.0263
h  0.928 
*
 0.7777
0.0313

Example – cont.
• The size of one heating oil contract is 42,000 gallons
• The spot price is 1.94 and the futures price is 1.99
(both dollars per gallon) so that
V A  1.94  2,000,000  3,880,000
VF  1.99  42,000  83,580
• Optimal number of contracts assuming no daily

settlement  0.7777  2,000,000 42,000  37.03
• Optimal number of contracts after tailing
 0.7777  3,880,000 83,580  36.10

Hedging with futures
• A fund manager is responsible for a diversified
portfolio of shares. Towards the end of 2012 she was
concerned about short term volatility in the stock
market and decided to protect the portfolio for the
remainder of the year by hedging with futures.
• Date of hedge was 1st November 2013.
• The FTSE 100 index was a close match for the portfolio
so she hedged with FTSE 100 index futures, using
contracts expiring in 21st December, in 50 days.
– Value of portfolio = £675m
– FTSE 100 spot price = 5861.9
– FTSE 100 futures price= 5836.5
• Long in asset – hedge by going short in futures
Value of portfolio
No of short contracts 
value of futures contract (on index  £10)
£675m
N  11,565.15 or 11,565 contracts @ F0  5836.5
5836.5  £10
• The fund manager held the position until

expiry on 21st December. The dividends on the
portfolio over the period were worth
£3.3873m

Outcome at expiration on 21st December
FTSE 100 index = 5940
• The spot index has risen by 1.3323% (5861.9 to
5940)
• Assuming the portfolio tracked the index, its
value also rose by 1.3323% from £675m to
£683.993m.
• The futures price converged with the spot price at
expiration so the futures settlement price was
5940. (FT=ST = 5940).
• Gain/Loss = (F0-FT) x £10 x 11,565

= (5836.5 – 5940) x £115,650
= -103.5 x £115,565
= - £11,969,775
35
• Net position
Portfolio £683.993m
Dividends £ 3.3873m
Loss on Futures - £ 11.969775m
Net £675.410525m
Value on 1st November = £675m

Value on 21st December = £675.410525m
365
Annualised Return  (1  0.0608%) 50
 1  0.44%
A perfect hedge removes all risk – the position earns risk
free rate. So, if this is a perfect hedge then rf = 0.44%
p.a.
But this is only if portfolio perfectly replicates the FTSE
100 index (which is our assumption).
Optimal Number of Contracts
QA Size of position being hedged (units)
QF Size of one futures contract (units)
VA Value of position being hedged (=spot price time QA)
VF Value of one futures contract (=futures price times QF)
Optimal number of contracts

Optimal number of contracts if after tailing adjustment to allow
no tailing adjustment for daily settlement of futures
h *Q A h *V A
 
QF VF

Hedging when beta differs
Diversified equity portfolio worth £200m; beta=1.25;
Market index = 5000; beta of index=1.0
To hedge the portfolio with futures:
Hedge rate =
No of short contracts required to remove all market
risk:
Beta of overall position = 0

Change portfolio beta
To increase portfolio beta from 1.25 to 1.5 (i.e.
increase market risk) use Long contracts
(Market risk is increased by 20%)

Change portfolio beta
To decrease portfolio beta from 1.25 to 0.75 (i.e.
decrease market risk)
(That is 2000 Short contracts)

(Market risk is decreased by 40%)
What if beta is not 1.0?
Hedge with contracts on the FTSE 250,beta=1.13
e.g. Increase beta to 1.5
e.g. Decrease beta to 0.75
Long asset + Long Futures = Raise Risk

Long asset + Short Futures = Reduce Risk 41
Pricing of Futures
Spot-Futures Parity
Theory: An investor requires an asset at time T.
There are TWO ways to achieve this:
a) Buy the asset today at spot price S0 and hold

until time T.
b) Enter a contract today to buy the asset at
time T at the Futures price F0.
Since both strategies have the same outcome at

time T, then they must have the same price
Buy the asset today
Buy at spot price S0.
The cost of holding the asset until time T is the
interest lost on the alternative of holding cash.
Cost of ‘buy-and-hold’ = S0 + interest lost
Cost of carry
The cost of holding the asset is reduced by any

income received, e.g. dividends on shares
Cost of ‘buy-and-hold’ = S0 + interest lost –
income received. D.Andriosopoulos - AG929 & AG925 43
Futures price – cost of buy and hold
Where I = PV of income received

r = risk free rate
T= time (in years) to expiration of contract
With continuous compounding :

Roll and Carry
Fair value :
If r > I then negative carry
(typical case)
Deferred futures should
trade at a premium to
nearby futures and the roll
is quoted as a positive
number
If r < I then positive carry – roll
quoted as negative
When short term interest
rates are very low it can
happen.

Evaluation roll and implicit financing
Estimate the fair (present) value of nearby and
deferred futures. OR estimate implied financing
(imp fin). Recipe for imp fin:
– Price of Futuresnearby
– No of days between expiration of nearby and
deferred
– Dividends accrued between expiration of nearby
and deferred (Divbetween) and dividends until
expiration (Divtonearby)
360 𝑅𝑜𝑙𝑙+𝐷𝑖𝑣𝑏𝑒𝑡𝑤𝑒𝑒𝑛
𝐼𝑚𝑝 𝐹𝑖𝑛 = 𝑥
𝑑𝑎𝑦𝑠𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝐹𝑢𝑡𝑢𝑟𝑒𝑠𝑛𝑒𝑎𝑟𝑏𝑦+𝐷𝑖𝑣𝑛𝑒𝑎𝑟𝑏𝑦

Implied financing example
Assume: Roll quoted at -5.75 index points. 91 days
between nearby and deferred futures.
Futuresnearby=1,1176. We estimate 6.75 index points
dividends accrued between expirations and 1.15
index points until expiration of nearby.
360 −5.75 + 6.75
𝐼𝑚𝑝 𝐹𝑖𝑛 = 𝑥 = 0.336%
91 1,176 + 1.15
If prevailing rates are say 0.43% and Imp Fin is

0.336% the roll is cheap – buy deferred sell nearby
If prevailing rates are say 0.43% and Imp Fin is 0.5%
the roll is rich – sell deferred and buy nearby
“roll” cheap or rich?
Roll = Futuresdeferred - Futuresnearby
Implicit Financing < Prevailing Rate

Roll is “cheap” : long deferred and short nearby
Implicit Financing > Prevailing Rate

Roll is “rich”: short deferred and long nearby

Currency Futures pricing
1 + (𝑟ℎ × 𝑇)
𝐹=𝑆×
1 + (𝑟𝑓 × 𝑇)
or
𝑟ℎ −𝑟𝑓 𝑇
𝐹 = 𝑆𝑒
• F= Futures
• S= Spot rate
• e= natural number (2.71828)
• rh= interest rate of home currency
• rf= interest rate of foreign currency
Currency Futures pricing example
US interest rate is 5% and UK interest rate is 8%.
Spot $/£ is $1.90/£. The price of a 6-month (180
days) futures contract which is 100 days into the
contract has 80 days to maturity.
1  (0.05 * 0.2222)
Hence:F  $1.90 / £   $1.8876 / £
1  (0.08 * 0.2222)
T= (180-100)/360 = 0.2222
or, F  $1.90 / £  e ( 0.050.08)((180100) / 360)  $1.8874 / £

Futures prices examples
Recall G4S example, on 8th January.
Spot price of shares is 263.1p (S0)
Expiration dates of futures contracts Futures Price Expiration in
(p)
15th March 2013 263.34 66 days
21st June 2013 257.49 164 days
20th September 2013 257.84 255 days
20th December 2013 258.20 346 days
The model:
If I = 0 then
March contract, F0 = 263.34p
No dividends are due on G4S shares before 15
March. (Assume risk free rate is 0.5% pa)
Quoted
Price
If F0>S0 No dividend is due before futures expiration date.

If S0>F0 A dividend is due before futures expiration date.

June contract, F0=257.49p (164 days to
expiration)
• Risk free rate is 0.5% pa
• A dividend is due on G4S shares before the
futures contracts expires on 21st June.
• What is the amount of dividend?
• PV of dividend:

Pricing dividend
Assume Div due in 120 days:
6.198p per share

Dividend Yield approach
• But what if we don’t know the amount of
dividends to be paid or when they are to be
paid? (Assume the market knows that G4S
intends to provide a dividend yield of 5.3%)
• The model is:
F0=257.49
Dividend Yield approach
• This approach can only be used if the firm’s
planned annual dividend yield is known and a
dividend is due to be paid during the life of
the futures contract.
• The dividend yield reflects the amount of the
dividend at the time of the payment
• If NO dividends are to be paid during the
futures contract the model is reduced back to:

Mispriced Futures and Arbitrage
G4S on 8th January spot price is 263.1p
The theoretically correct price for June futures is
257.49p
Suppose the quoted price on 8th January for June
futures is 262p.
The quoted price is too high, hence offering an
arbitrage opportunity.
-Futures overpriced Sell futures to gain
262-257.49 = 4.51
-Short futures @ 262
- Borrow and buy share @ 263.1
Arbitrage outcome on 21st June
You have: share + short futures contract + debt
to repay
Sell share as per futures contract 262.0
FV of dividends received 6.202
Repay loan (𝐹0 = 263.1𝑒 (0.005)

164
365 -263.692
Arbitrage gain/loss 4.51

Arbitrage
Gain/Loss on short futures = F0 – FT
(FT=ST (convergence))
ST=200 Sell share 200

gain on Future 62 (262-200)
262
ST=400 Sell share 400

loss on Future -138 (262-400)
262
Index futures
On 1st November 2013, FTSE 100 index is 5861.9
Futures price of contract expiring on 21st Dec (i.e. in 50 days) was
5836.5
S0=5861.9 F0=5836.5
To find the dividends on assets underlying FTSE100
From the Futures pricing

solve for Income received:
Remember: 𝐹0 = (𝑆0 −𝐼)𝑒 𝑟∗𝑇

5861.9 − 5832.5038 = 29.3962
50
0.005×365
𝐼 = 29.3962𝑒 = 29.41634
29.41634 x £10 x 11,515 = £3.3873m

Dividend Yield on FTSE 100 index
The underlying asset is a portfolio of the largest 100
stocks that comprise the index. It is typical to refer to
a dividend yield on the index rather than a cash
amount of dividends.
From the futures price we can estimate the expected
dividend yield on the index:
From this we can derive:
61
Deriving risk free rate from futures prices
No dividend
It is straightforward if there is no dividend due
on the underlying.
Use the formula: so
G4S March contracts:

S0 = 263.1p F0 = 263.34p T = 66 days

Deriving risk free rate from futures prices
With dividend
e.g G4S June contracts

S0 = 263.1p F0 = 257.49p I = 6.188p T = 164 days

Futures vs Forwards
Futures Forwards
Exchange traded Over The Counter (OTC)
Standardised contracts Tailor-made
Closed out prior to delivery Delivery at end of delivery date
Daily settlement of profit/loss Full settlement at delivery

More flexible after entering the contract More flexible when designing the contract
Zero default risk Default risk
Liquid contracts Illiquid contracts

Forward Prices
• Is there a difference between forward and futures
prices?
• At expiration they both equal the spot price, FT =ST
• Consider a forward and a futures contract on the
same asset with the same expiration date.
• During the life of the contracts they will generally
have the same price:
– There is no interest rate uncertainty or there is no
correlation between interest rates and futures prices.
– Default risk is not priced in the forward market.

A futures price is not the same as
value
• The value of a financial asset (e.g. share) is the same as
its market price – assuming efficient stock market
• An investor buys a share for £5, has an asset with value
= £5.
• The buyer of a futures contract (long contract) does not
pay for it, but agrees to buy at a future date at the
futures price.
• If she wanted to sell immediately by a reversing trade
at the same futures price (short contract) she incurs
neither gain or loss, i.e. the futures position has a zero
value.
• When initially set up, value of futures contract = zero

Value during the life of the contract at
t, before expiration date
• The futures contract only has value if a reversing trade
occurs, ie the value to the investor is what she would
get by closing the position.
• As gains or losses on futures are marked to market the
gains or losses are settled each day. So, immediately
after each settlement the contract reverts to zero
value.
• The value of a futures contract just before marking to
market is equal to the change in futures price since the
previous marking to market.
• Value of Long contract at t, Vt = Ft - Ft-1
• Value of Short contract at t, Vt = Ft-1 - Ft
Value of forward contracts
• As with futures contracts, forwards have zero value when
they are initially set up.
• Forward contracts are fully settled at expiration, time T.
• Hence: value of long forward at expiration = ST-F0
value of short forward at expiration = F0 – ST
The value of a forward during its life, before expiration at

time T, is different.
Different from futures No
The difference lies on the daily settlement (marking to
market) D.Andriosopoulos - AG929 & AG925 68
Value of forward contract at time t
(before expiration)
• Consider: alternatives at time t:
– A long forward contract worth ST-F0 at expiration
– Buy the asset for St
Borrow the PV of F0 to be repaid at T (i.e. for the
period T-t)
At time T, the portfolio is worth: ST – F0
Value of asset Repay Loan

What if there is income on the
underlying asset?
• In that case we subtract the present value
from the asset price as follows:
• Value of a forward contract at time t:

f = St – I(t,T) – Ke–r(T-t)
where I(t,T) = present value at time t of any

income on underlying due before expiration.

Value of forward example
A long forward contract on a non-dividend-paying
stock was entered into some time ago. It currently
has 3 months to maturity. The risk-free rate of
interest is 5% per annum, the stock price is £25 and
the delivery price is £24.
The 3-month forward price, F0, is given by
F0 = £25e0.5x0.25= £25.31
The value of the forward is

f = (£25.31 – £24)e-0.05*0.25 ≈ £1.30
Summarising value for futures and
forwards
• Value of long futures Ft - Ft-1
Before mark
to market
• Value of short futures Ft-1 - Ft
• Value of long forward f = St – I(t,T) – Ke–r(T-t)
• Value of short forward f = Ke–r(T-t) + I(t,T) - St

Importance of establishing the value of
derivative contracts
• It is important for fin. Institutions (and every
other organisation) to know the value of their
outstanding derivatives, so that can be shown as
assets and liabilities on their balance sheet.
• It is essential to understand whether derivatives
are creating or destroying firm value.
• However, as their essential purpose is to hedge,
then the value of the derivatives should have an
offsetting effect on the firms’ transactions in the
underlying asset, (e.g. commodity, foreign
currency, etc.)

Thank you!

Lecture4 - Futures and Forwards

Загружено:

Сведения о документе

Оригинальное название

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

Lecture4 - Futures and Forwards

Загружено:

Авторское право:

Доступные форматы

Lecture 4

Futures & Forwards

Refs.: Hull chapters 2, 3 & 5

D.Andriosopoulos - AG929 & AG925 1

D.Andriosopoulos - AG929 & AG925 3

D.Andriosopoulos - AG929 & AG925 4

D.Andriosopoulos - AG929 & AG925 5

D.Andriosopoulos - AG929 & AG925 6

Source: Thomson Reuters

D.Andriosopoulos - AG929 & AG925

D.Andriosopoulos - AG929 & AG925 8

D.Andriosopoulos - AG929 & AG925 9

1 1,241.00 −1,800 − 1,800 10,200

2 1,238.30 −540 −2,340 9,660

….. ….. ….. ….. ……

6 1,236.20 −780 −2,760 9,240

7 1,229.90 −1,260 −4,020 7,980 4,020

8 1,230.80 180 −3,840 12,180

….. ….. ….. ….. ……

16 1,226.90 780 −4,620 15,180

D.Andriosopoulos - AG929 & AG925 10

Clearing House Clearing House

Long Trader Short Trader

D.Andriosopoulos - AG929 & AG925 11

Clearing House Clearing House

Long Trader Short Trader

D.Andriosopoulos - AG929 & AG925 12

• Spot Price is the price an asset can be bought and sold

Open High Low Settle Change Volume Open Int

Aug 2010 71.25 72.77 70.42 72.54 2.44 3,746 115,305

Dec 2010 74.00 75.34 73.17 75.23 2.19 5,055 196,033

Dec 2011 77.01 78.59 76.51 78.53 2.00 4,175 100,674

Dec 2012 78.50 80.21 78.50 80.18 1.86 1,258 70,126

D.Andriosopoulos - AG929 & AG925 15

This is called a reversing trade or closing out

• i.e. 10 x 1,000 x 15p = £1,500 (for 10 contracts)

Assume maintenance margin is 75% of initial margin

D.Andriosopoulos - AG929 & AG925 18

To close-out a long position it is FT - F0

Typically Gains/Losses go through P/L (Fair Value accounting, mark-to-market)

(Depends on Accounting Rules e.g. IAS 39, IFRS 9 https://www.iasplus.com/en/standards/ifrs/ifrs9)

D.Andriosopoulos - AG929 & AG925 19

The speculator decides to close her position on 14 Jan.

D.Andriosopoulos - AG929 & AG925 21

= (6072.5 – 6014.0) x £10 x 500 contracts

= 58.5 x £5,000 = £292,500 (over 5 trading days)

Note: Margin = £3,020/contract =

D.Andriosopoulos - AG929 & AG925 22

• In rational, well-informed markets equivalent assets have the same

• Arbitrage opportunities can occur if the equilibrium relationship

• Equilibrium is based on the theoretical relationship between futures

D.Andriosopoulos - AG929 & AG925 25

F1 : Futures price at time hedge is set up

Gain on Futures F2 −F1

Net amount paid S2 − (F2 −F1) =F1 + b2

D.Andriosopoulos - AG929 & AG925 26

F1 : Futures price at time hedge is set up

Gain on Futures F1 −F2

Net amount received S2 + (F1 −F2) =F1 + b2

D.Andriosopoulos - AG929 & AG925 27

D.Andriosopoulos - AG929 & AG925 28

D.Andriosopoulos - AG929 & AG925 29

D.Andriosopoulos - AG929 & AG925 31